On the Correspondence Between Management's Discussion and Analysis and the Face of the Financial Statements

63 Pages Posted: 26 Jul 2022

See all articles by Thomas C. Hagenberg

Thomas C. Hagenberg

Northwestern University - Kellogg School of Management

Jeff L. McMullin

Indiana University - Kelley School of Business - Department of Accounting

Rafael Rogo

University of Cambridge - Judge Business School

Date Written: June 30, 2022

Abstract

We develop a theory and a text-analytic method to model managers’ translation of economic activity into the preparation of Management’s Discussion and Analysis (MD&A). Our approach considers both quantitative and qualitative accounting information by linking numerical changes in the financial statements with year-over-year textual modifications to the MD&A. We use our method to construct a measure of the expected disclosure, given firms’ underlying economics as captured by changes in the financial statements. Next, we examine deviations from this expectation to examine how the market incorporates different aspects of disclosures into stock prices. We theorize and document that the edit patterns of MD&A modifications and their connection to the financial statements convey different signals about firm value. While the market often correctly interprets the sign of those signals, we show that the immediate response is severely incomplete, providing a more nuanced view of the breakdown in communication between managers and investors.

Keywords: Management’s Discussion and Analysis, Text Analysis, Topic Modeling, Financial Statement Analysis, Disclosure Informativeness

JEL Classification: C18, M4

Suggested Citation

Hagenberg, Thomas and McMullin, Jeff L. and Rogo, Rafael, On the Correspondence Between Management's Discussion and Analysis and the Face of the Financial Statements (June 30, 2022). Available at SSRN: https://ssrn.com/abstract=4154534 or http://dx.doi.org/10.2139/ssrn.4154534

Thomas Hagenberg

Northwestern University - Kellogg School of Management ( email )

2211 Campus Drive
Evanston, IN 60208
United States

Jeff L. McMullin (Contact Author)

Indiana University - Kelley School of Business - Department of Accounting ( email )

1309 E. 10th Street
Bloomington, IN 47405
United States

Rafael Rogo

University of Cambridge - Judge Business School ( email )

Trumpington Street
Cambridge, CB2 1AG
United Kingdom

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